| OPNET TECHNOLOGIES INC ITEM 1A RISK FACTORS The following important factors, among others, could cause actual results to differ materially from those indicated by forward-looking statements made in this Annual Report and presented elsewhere by management from time to time |
| Our operating results may fluctuate significantly as a result of factors outside of our control, which could cause the market price of our stock to decline |
| Our operating results have fluctuated in the past, and are likely to fluctuate significantly in the future |
| Our financial results may as a consequence fall short of the expectations of public market analysts or investors, which could cause the price of our common stock to decline |
| Our revenue and operating results may vary significantly from quarter to quarter due to a number of factors, many of which are beyond our control |
| Factors that could affect our operating results include: • the timing of large orders; • changes in the proportion of software arrangements requiring contract accounting; • changes in the mix of our sales, including the mix between higher margin software products and lower margin services and maintenance, and the proportion of our license sales requiring us to make royalty payments; • the timing and amount of our marketing, sales, and product development expenses; • the cost and time required to develop new software products; • the introduction, timing, and market acceptance of new products introduced by us or our competitors; • changes in network technology or in applications, which could require us to modify our products or develop new products; • general economic conditions, which can affect our customers’ purchasing decisions, the length of our sales cycle, and our customers’ ability to pay us on time, if at all; • changes in our pricing policies or those of our competitors; and • the timing and size of potential acquisitions by us |
| We expect to make significant expenditures in all areas of our business, particularly sales and marketing operations, in order to promote future growth |
| Because the expenses associated with these activities are relatively fixed in the short term, we may be unable to adjust spending quickly enough to offset any unexpected shortfall in revenue growth or any decrease in revenue levels |
| In addition, our revenue in any quarter depends substantially on orders we receive and ship in that quarter |
| We typically receive a significant portion of orders in any quarter during the last month of the quarter, and we cannot predict whether those orders will be placed and shipped in that period |
| If we have lower revenue than we expect, we probably will not be able to respond quickly enough to reduce our operating expenses |
| Therefore, any significant shortfall in revenue or delay of customer orders could have an immediate adverse effect on our operating results in that quarter |
| For all of these reasons, quarterly comparisons of our financial results are not necessarily meaningful and you should not rely on them as an indication of our future performance |
| 11 ______________________________________________________________________ [41]Table of Contents The market for intelligent network management software is new and evolving, and if this market does not develop as anticipated, our revenue could decline |
| We derive all of our revenue from the sale of products and services that are designed to allow our customers to manage the performance of networks and applications |
| Accordingly, if the market for intelligent network management software does not continue to grow, we could face declining revenue, which could ultimately lead to our becoming unprofitable |
| The market for intelligent network management software solutions is in the early stages of development |
| Therefore, we cannot accurately assess the size of the market and may be unable to identify an effective distribution strategy, the competitive environment that will develop, and the appropriate features and prices for products to address the market |
| If we are to be successful, our current and potential customers must recognize the value of intelligent network management software solutions, decide to invest in the management of their networks, and, in particular, adopt and continue to use our software solutions |
| Our customers are primarily in four target groups and our operating results may be adversely affected by changes in one or more of these groups |
| Our software solutions and services are designed to meet the needs of enterprises, United States government agencies, service providers, and network equipment manufacturers, and we market our solutions and services to those four customer groups |
| Consequently, our financial results depend, in significant part, upon the economic conditions of enterprises, United States government agencies, service providers, and network equipment manufacturers |
| An economic downturn or adverse change in the regulatory environment or business prospects for one or more of these customer groups may decrease our revenue or lower our growth rate |
| The United States Department of Defense may not extend one consulting contract with us, which could harm our business |
| In January 2003, we were awarded a consulting contract with the United States Department of Defense |
| The funding under this contract for calendar year 2003 was dlra3cmam070, and there are four successive option years under the contract that may be exercised by the United States Department of Defense in its discretion |
| In January 2004, the United States Department of Defense exercised the first of four possible contract extensions |
| The funding under this contract for calendar year 2004 was dlra3cmam509 |
| In January 2005, United States Department of Defense exercised the second of four possible contract extensions |
| The funding under this contract for calendar year 2005 was dlra2cmam965 |
| In February 2006, United States Department of Defense exercised the third of four possible contract extensions |
| The funding under this contract for calendar year 2006 was dlra2cmam899 |
| Our results of operations could be adversely affected if any of the remaining options are not exercised, the contract otherwise does not receive additional funding, or has a reduction in funding |
| A decline in information technology spending may result in a decrease in our revenue or lower our growth rate |
| A decline in the demand for information technology among our current and prospective customers may result in decreased revenue or a lower growth rate for us because our sales depend, in part, on our customers’ budgets for new or additional information technology systems and services |
| A continued economic downturn may cause our customers to reduce or eliminate information technology spending and force us to lower prices of our solutions, which would substantially reduce the number of new software licenses we sell and the average sales price for these licenses |
| Accordingly, we cannot assure you that we will be able to increase or maintain our revenue |
| Our sales to United States government agencies subject us to special risks that could adversely affect our business |
| We derive a substantial portion of our revenue from sales directly or indirectly to United States government agencies |
| Transactions with United States government agencies accounted for approximately 43prca, 47prca, and 44prca of our total revenue for fiscal 2006, fiscal 2005, and fiscal 2004, respectively |
| Government sales entail a variety of risks including: • Government contracts are subject to the approval of appropriations by the United States Congress to fund the expenditures by the agencies under these contracts |
| Congress often appropriates funds for 12 ______________________________________________________________________ [42]Table of Contents government agencies on a yearly basis, even though their contracts may call for performance over a number of years |
| • A significant decline in government expenditures generally, or a shift in budget priorities away from agencies or programs that we support, could cause a material decline in our government business |
| In particular, a decline in government spending on information technology or related services could hurt our government business |
| We believe that the GSA schedule facilitates our sales to United States government agencies |
| The loss of the GSA schedule covering our products and services could adversely affect our results of operations |
| • We must comply with complex federal procurement laws and regulations in connection with government contracts, which may impose added costs on our business |
| • Some of our government business requires that we maintain facility security clearances, and requires some of our employees to maintain individual security clearances |
| If we were to lose these clearances, our government business might decline |
| • The federal government audits and reviews the performance of federal contractors on contracts, pricing practices, cost structure, and compliance with applicable laws, regulations, and standards |
| An audit of our work could result in a finding that we overcharged the government, which could result in an adjustment to our previously reported operating results |
| If a government audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines, and suspension or debarment from doing business with United States federal government agencies |
| • Many of our government contracts are firm fixed-price contracts |
| To the extent that the assumptions we have used in pricing these contracts prove inaccurate, we could incur and accrue losses on contracts, which would adversely affect our operating results |
| • A portion of our sales to the United States government are made indirectly as a subcontractor to another government contractor, referred to as the prime contractor, who has the direct relationship with the government |
| We also team with prime contractors to bid on competitive government opportunities for which we hope to serve as a subcontractor |
| If prime contractors lose existing business on which we serve as a subcontractor, or fail to win the competitive bids on which we team with them, our government business would be hurt |
| • We could face expense and delay if any or our competitors, or competitors of the prime contractors to which we serve as a subcontractor, protest or challenge contract awards made to us or our prime contractors pursuant to competitive bidding |
| • Federal government contracts contain provisions and are subject to laws and regulations that provide government clients with rights and remedies not typically found in commercial contracts |
| These rights and remedies allow government clients, among other things, to terminate existing contracts, with short notice, for convenience without cause; reduce or modify contracts or subcontracts; and claim rights in products, systems, and technology produced by us |
| If our newest products, particularly those targeted primarily for enterprises and United States government agencies, do not gain widespread market acceptance, our revenue might not increase and could even decline |
| We expect to derive a substantial portion of our revenue in the future from sales to enterprises and United States government agencies of version 11dtta5 of IT Guru, which was released in October 2005, and its associated modules including Application Characterization Environment, ACE Decode Module, ACE Advanced Console, NetDoctor, Planning and Design, and Flow Analysis, and VNE Server 3dtta5, which was released in October 2005 |
| Our business depends on customer acceptance of these products and our revenue may not increase, or may even 13 ______________________________________________________________________ [43]Table of Contents decline, if our target customers do not adopt and expand their use of our products |
| In addition, sales of our OPNET Modeler product, which we have been selling since 1987, have fluctuated from quarter-to-quarter, including periods of declining sales |
| Sales of our OPNET Modeler could decline in the future for a variety of reasons, including market saturation and the financial condition of network equipment manufacturers, and if sales of our newer products do not grow at a rate sufficient to offset the shortfall, our revenue would decline |
| We may not be able to grow our business if service providers do not buy our products |
| An element of our strategy is to increase sales to service providers of SP Guru and WDM Guru, both launched in fiscal 2002, and VNE Server, which was launched in fiscal 2003 |
| Accordingly, if our products fail to perform favorably in the service provider environment, or fail to gain wider adoption by service providers, our business and future operating results could suffer |
| Our lengthy and variable sales cycle makes it difficult to predict operating results |
| It is difficult for us to forecast the timing and recognition of revenue from sales of our products because prospective customers often take significant time evaluating our products before licensing them |
| The period between initial customer contact and a purchase by a customer may vary from three months to more than a year |
| Our prospective customers routinely require education regarding the use and benefit of our products |
| This may also lead to delays in receiving customers’ orders |
| If we do not successfully expand our sales force, we may be unable to increase our sales |
| We sell our products primarily through our direct sales force, and we must expand the size of our sales force to increase revenue |
| If we are unable to hire or retain qualified sales personnel, if newly hired personnel fail to develop the necessary skills to be productive, or if they reach productivity more slowly than anticipated, our ability to increase our revenue and grow our business could be compromised |
| Our sales people require a long period of time to become productive, typically three to nine months |
| The time required to reach productivity, as well as the challenge of attracting, training, and retaining qualified candidates, may make it difficult to meet our sales force growth targets |
| Further, we may not generate sufficient sales to offset the increased expense resulting from growing our sales force, or we may be unable to manage a larger sales force |
| Our ability to increase our sales will be impaired if we do not expand and manage our indirect distribution channels |
| To increase our sales, we must, among other things, further expand and manage our indirect distribution channels, which consist primarily of international distributors and original equipment manufacturers and resellers |
| If we are unable to expand and manage our relationships with our distributors, our distributors are unable or unwilling to market and sell our products effectively, or we lose existing distributor relationships, we might not be able to increase our revenue |
| Our international distributors and original equipment manufacturers and resellers have no obligation to market or purchase our products |
| In addition, they could partner with our competitors, bundle or resell competitors’ products, or internally develop products that compete with our products |
| We may not be able to successfully manage our expanding operations, which could impair our ability to operate profitably |
| Our growth has sometimes strained, and may in the future continue to strain, our managerial, administrative, operational, and financial resources and controls |
| We plan to continue to expand our operations and increase the number of our full-time employees |
| Our ability to manage growth will depend in part on our ability to continue to enhance our operating, financial, and management information systems |
| Our personnel, systems, and controls may not be adequate to support our growth |
| In addition, our revenue may not continue to grow at a sufficient rate to absorb the costs associated with a larger overall employee base |
| 14 ______________________________________________________________________ [44]Table of Contents If we are unable to introduce new and enhanced products on a timely basis that respond effectively to changing technology, our revenue may decline |
| Our market is characterized by rapid technological change, changes in customer requirements, frequent new product and service introductions and enhancements, and evolving industry standards |
| If we fail to develop and introduce new and enhanced products on a timely basis that respond to these changes, our products could become obsolete, demand for our products could decline and our revenue could fall |
| Advances in network management technology, software engineering, and simulation technology, or the emergence of new industry standards, could lead to new competitive products that have better performance, more features, or lower prices than our products and could render our products unmarketable |
| Our future revenue is substantially dependent upon our existing customers continuing to license additional products, renew maintenance agreements, and purchase additional services |
| Our existing customers have traditionally generated additional revenue from consulting services, renewed maintenance agreements, and purchase of additional software licenses, which represents a majority of our annual revenue |
| The maintenance agreements are generally renewable at the option of the customers and there are no mandatory payment obligations or obligations to license additional software |
| In addition, customers may decide not to purchase additional products or services |
| If our existing customers fail to renew their maintenance agreements or purchase additional products or services, our revenue could decrease |
| Increases in professional services revenue as a percentage of total revenue could decrease overall margins |
| We realize lower margins on professional service revenue than we do on other types of revenue |
| As a result, if professional services revenue increases as a proportion of total revenue, our gross margins will be lower |
| If we fail to retain our key personnel and attract and retain additional qualified personnel, we might not be able to maintain our current level of revenue |
| Our future success and our ability to maintain our current level of revenue depends upon the continued service of our executive officers and other key sales and research and development personnel |
| The loss of any of our key employees, in particular Marc A Cohen, our Chairman of the Board and Chief Executive Officer, and Alain J Cohen, our President and Chief Technology Officer, could also adversely affect our ability to pursue our growth strategy |
| We do not have employment agreements or any other agreements that obligate any of our officers or key employees to remain with us |
| We must also continue to hire highly qualified individuals, particularly software engineers and sales and marketing personnel |
| Our failure to attract and retain technical personnel for our product development, consulting services, and technical support teams may limit our ability to develop new products or product enhancements |
| Competition for these individuals is intense, and we may not be able to attract and retain additional highly qualified personnel in the future |
| In addition, limitations imposed by federal immigration laws and the availability of visas could impair our ability to recruit and employ skilled technical professionals from other countries to work in the United States |
| Our international operations subject our business to additional risks, which could cause our sales or profitability to decline |
| We plan to increase our international sales activities, but these plans are subject to a number of risks that could cause our sales to decline or could otherwise cause a decline in profitability |
| These risks include: • difficulty in attracting distributors that will market and support our products effectively; • greater difficulty in accounts receivable collection and longer collection periods; • the need to comply with varying employment policies and regulations that could make it more difficult and expensive to manage our employees if we need to establish more direct sales or support staff outside the United States; 15 ______________________________________________________________________ [45]Table of Contents • potentially adverse tax consequences; • the effects of currency fluctuations; and • political and economic instability |
| We expect to face increased competition, which could cause us to lose sales, resulting in lower profitability |
| Increasing competition in our market could cause us to lose sales and become unprofitable |
| We believe that the market for intelligent network management software is likely to become more competitive as it evolves and the demand for intelligent network management solutions continues to increase |
| At least one of our current competitors and many of our potential competitors are larger and have substantially greater financial and technical resources than we do |
| In addition, it is possible that other vendors as well as some of our customers or distributors will develop and market solutions that compete with our products in the future |
| If our products contain errors and we are unable to correct those errors, our reputation could be harmed and our customers could demand refunds from us or assert claims for damages against us |
| Our software products could contain significant errors or bugs that may result in: • the loss of or delay in market acceptance and sales of our products; • the delay in introduction of new products or updates to existing products; • diversion of our resources; • injury to our reputation; and • increased support costs |
| Bugs may be discovered at any point in a product’s life cycle |
| We expect that errors in our products will be found in the future, particularly in new product offerings and new releases of our current products |
| Because our customers use our products to manage networks that are critical to their business operations, any failure of our products could expose us to product liability claims |
| In addition, errors in our products could cause our customers’ networks and systems to fail or compromise their data, which could also result in liability to us |
| Product liability claims brought against us could divert the attention of management and key personnel, could be expensive to defend, and may result in adverse settlements and judgments |
| Our software products rely on our intellectual property, and any failure to protect our intellectual property could enable our competitors to market products with similar features that may reduce our revenue and could allow the use of our products by users who have not paid the required license fee |
| If we are unable to protect our intellectual property, our competitors could use our intellectual property to market products similar to our products, which could reduce our revenue |
| In addition, we may be unable to prevent the use of our products by persons who have not paid the required license fee, which could reduce our revenue |
| Our success and ability to compete depend substantially upon the internally developed technology that is incorporated in our products |
| Policing unauthorized use of our products is difficult, and we may not be able to prevent misappropriation of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as those in the United States |
| Others may circumvent the patents, copyrights, and trade secrets we own |
| In the ordinary course of business, we enter into a combination of confidentiality, non-competition, and non-disclosure agreements with our employees |
| These measures afford only limited protection and may be inadequate, especially because our employees are highly sought after and may leave our employ with significant knowledge of our proprietary information |
| In addition, any confidentiality, non-competition and non-disclosure agreements we enter into may be found to be unenforceable, or our copy protection mechanisms embedded in our software products could fail or could be circumvented |
| 16 ______________________________________________________________________ [46]Table of Contents Our products employ technology that may infringe on the proprietary rights of others, and, as a result, we could become liable for significant damages |
| We expect that our software products may be increasingly subject to third-party infringement claims as the number of competitors in our industry segment grows and the functionalities of products in different industry segments overlap |
| Regardless of whether these claims have any merit, they could: • be time-consuming to defend; • result in costly litigation; • divert our management’s attention and resources; • cause us to delay or cease product shipments; or • require us to enter into royalty or licensing agreements |
| These royalty or licensing agreements may not be available on terms acceptable to us, if at all |
| A successful claim of product infringement against us or our failure or inability to license the infringed or similar technology could adversely affect our business because we would not be able to sell the affected product without redeveloping it or incurring significant additional expense |
| Future interpretations of existing accounting standards could adversely affect our operating results |
| The Securities and Exchange Commission, American Institute of Certified Public Accountants and various other authoritative accounting bodies continue to issue interpretations and guidance for applying the relevant standards to a wide range of sales contract terms and business arrangements that are prevalent in the software industry |
| Future interpretations of existing accounting standards or changes in our business practices could result in future changes in our revenue recognition accounting policies that could have a material adverse effect on our results of operations |
| As with other software vendors, we may be required to delay revenue recognition into future periods, which could adversely affect our operating results |
| We have in the past had to, and in the future may have to, defer recognition for license fees due to several factors, including whether: • software arrangements include undelivered elements for which we do not have vendor specific evidence of fair value; • we must deliver services for significant customization, enhancements and modifications of our software; • the transaction involves material acceptance criteria or there are other identified product-related issues; • the transaction involves contingent payment terms or fees; • we are required to accept a fixed-fee services contract; or • we are required to accept extended payment terms |
| Because of the factors listed above and other specific requirements under accounting principles generally accepted in the United States of America for software revenue recognition, we must have very precise terms in our software arrangements in order to recognize revenue when we initially deliver software or perform services |
| Negotiation of mutually acceptable terms and conditions can extend the sales cycle, and sometimes we do not obtain terms and conditions that permit revenue recognition at the time of delivery |
| 17 ______________________________________________________________________ [47]Table of Contents If we undertake acquisitions, they may be expensive and disruptive to our business and could cause the market price of our common stock to decline |
| We completed the NetMaker, WDM NetDesign and Altaworks acquisitions in March 2001, January 2002 and October 2004, respectively |
| We may continue to acquire or make investments in companies, products or technologies if opportunities arise |
| Any acquisition could be expensive, disrupt our ongoing business, distract our management and employees, and adversely affect our financial results and the market price of our common stock |
| We may not be able to identify suitable acquisition or investment candidates, and if we do identify suitable candidates, we may not be able to make these acquisitions or investments on commercially acceptable terms or at all |
| If we make an acquisition, we could have difficulty integrating the acquired technology, employees, or operations |
| In addition, the key personnel of the acquired company may decide not to work for us |
| We also expect that we would incur substantial expenses if we acquired other businesses or technologies |
| We might use cash on hand, incur debt, or issue equity securities to pay for any future acquisitions |
| If we issue additional equity securities, our stockholders could experience dilution and the market price of our stock may decline |
| Our products are subject to changing computing environments, including operating system software and hardware platforms, which could render our products obsolete |
| The evolution of existing computing environments and the introduction of new popular computing environments may require us to redesign our products or develop new products |
| Computing environments, including operating system software and hardware platforms, are complex and change rapidly |
| Our products are designed to operate in currently popular computing environments |
| Due to the long development and testing periods required to adapt our products to new or modified computing environments, our research and development efforts could be distracted and we could experience significant delays in product releases or shipments, which could result in lost revenue and significant additional expense |